Lessons from Japan's Lost Decades

Carl Delfeld, editor of Chartwell Advisor Global ETF Report, says Japan's massive stimulus package of the last two decades shows what works and what doesn't.

How would former Prime Minister Margaret Thatcher come down on the stimulus package [that just passed] Congress? Her view is probably close to the sentiments expressed in her autobiography entitled Margaret Thatcher: The Downing Street Years:

As governments tried to stimulate employment by pumping money into the economy, they caused inflation. The inflation led to higher costs. The higher costs meant loss of ability to compete. The few jobs that we had gained were soon lost; and so were a lot more with them. And then, from a higher level of employment and inflation, the process was started all over again, and each time around both inflation and unemployment rose.

As usual, some direct, logical, common sense from the Iron Lady.

It also may be useful to look at the trillions of dollars spent by Japan to lift the economy from a severe downturn caused by the bursting of a real estate bubble in the late 1980s. During those nearly two decades, Japan accumulated the largest public debt in the developed world-totaling 180% of its $5.5 trillion economy-while failing to generate a convincing recovery.

America's national debt, not counting new spending under the Obama Administration, now stands at 81% of GDP. The high point for America was in 1946 when it stood at 122% of GDP and then declined to a low of 33% in 1981.

Martin Fackler of the New York Times noted in an excellent article that one lesson is that it matters what gets built: Japan spent too much on increasingly wasteful roads and bridges and not enough in areas like education and social services, which studies show deliver more growth and jobs than basic infrastructure.

In total, Japan spent $6.3 trillion on construction-related public investment between 1991 and September of last year, according to the Cabinet Office. But many economists believe that it was not public works but an expensive restructuring of the debt-ridden banking system, combined with growing exports to China and the United States, that finally sparked an economic recovery.

Japan's experience also seems to argue for spending heavily on social issues. A 1998 report by the Japan Institute for Local Government, a nonprofit policy research group, found that every one trillion yen, or about $11.2 billion, spent on social services like care for the elderly and monthly pension payments added 1.64 trillion yen in growth. Financing for schools and education delivered an even bigger bang for the buck of 1.74 trillion yen, the report found.

But every one trillion yen spent on infrastructure projects in the 1990s increased Japan's gross domestic product by only 1.37 trillion yen, mainly by creating construction jobs and other logistical improvements such as reducing congestion.

As the stimulus package awaits the president's signature, he may wish to bring in some Japanese officials to learn their hard-earned lessons.